Thinking Backwards

Over at Office Hero Headquarters blog, I discovered an interesting note about a book titled Psychology of Intelligence Analysis. The post intrigued me both because of my recent research on the FBI's transformation post 9/11, as well as my body of work on decision-making and divergent thinking. I'm eager to read this book, after I learned that it discusses techniques intelligence analysts can employ to insure that they have examined an issue from divergent perspectives.

One such technique involves "thinking backwards." Here is an excerpt from the blog post on this subject:

"As an intellectual exercise, start with an assumption that some event you did not expect has actually occurred. Then, put yourself into the future, looking back to explain how this could have happened. Think what must have happened six months or a year earlier to set the stage for that outcome, what must have happened six months or a year before that to prepare the way, and so on back to the present. Thinking backwards changes the focus from whether something might happen to how it might happen. Putting yourself into the future creates a different perspective that keeps you from getting anchored in the present. Analysts will often find, to their surprise, that they can construct a quite plausible scenario for an event they had previously thought unlikely."

This technique reminds me of Gary Klein's work on "pre-mortem" exercises. Similar to thinking backwards, the pre-mortem involves imagining what a post-mortem analysis will be like BEFORE you actually launch a new project in your organization. Both thinking backwards and pre-mortem exercises help us discover and evaluate different scenarios for how the future might unfold. Leaders must remember that divergent thinking typically just doesn't happen on its own. It must be cultivated in most cases. These techniques help stimulate such productive divergence.

Annie's Homegrown

Last night, Annie's Homegrown CEO John Foraker spoke at Bryant University. He gave a terrific presentation about his firm's strategy, growth, and commitment to social responsibility. I found John's comments about values to be very interesting. He talked about how Annie's values were not written down when he joined the firm. He had not seen the merits of writing down a firm's mission and values in his prior jobs, but at Annie's, he found it invaluable. He described how the explicit statement of values really helped the firm identify who should be hired at Annie's, as well as what strategic options should be rejected because they did not fit with the values.

John also spoke about Annie's decision to expand beyond the organic/natural food channel. He noted that firms have to be very careful when making that leap to other channels such as club stores, mainstream grocery, etc. Conflicts can arise, and firms can lose their core base of customers if they are rejected by that original channel in which they excelled. John explained that Annie's took special care of its original organic/natural food channel partners such as Whole Foods. They worked to develop new and unique products for those partners. That special attention proves critical, particularly since the organic/natural channel proves ideal for many of the new product innovations that Annie's continues to bring to market. Too many firms make the mistake of simply offering the same products and services across all channels. For some companies, they find themselves ultimately rejected by some of their original channel partners, and the damage to the brand can be immense.

Thank you, John, for spending the evening with us last night!

The Pile of Cash at Apple

At the Apple shareholder meeting, Steve Jobs declared that he has no intention of using the company's giant cash balances (nearly $25 billion) to pay dividends to shareholders. Instead, he hopes to use that cash to fuel future investments.

Now, in most situations, I would be highly skeptical of a firm hoarding this amount of cash. I would be concerned that a CEO might use the cash to pursue a variety of value-destroying diversification strategies, or other profit-damaging initiatives. In Apple's case, though, I'm more willing to allow the company to hold these types of cash reserves. Why? In the end, the question for shareholders is this: Does the company have a sufficient amount of net present value positive projects in which it can invest this cash? If not, then the shareholders should be demanding dividends. They would want the cash so that they can invest it more productively on their own. However, if the firm does appear to have some very promising net present value projects in which to invest, then we would be much more comfortable letting the cash remain within the firm. To some extent, the best way to answer this question is to look at the firm's recent track record. Is it growing? Is it innovating? Is it delivering solid returns on investment? In Apple's case, they have a great track record of making sound investments that deliver profitable innovations. Their markets and products do not appear mature. It would seem reasonable to believe that Jobs and his team can use the cash very productively. Of course, though, that assessment needs to be updated continually as conditions change.

GM and Fritz Henderson

Alex Taylor of Fortune reports that GM is paying ex-CEO Fritz Henderson $59,090 per month for 20 hours of consulting work on international operations. I don't doubt that Henderson may have institutional knowledge that the firm wants to tap, but is this really worth $3,000 per hour? Wow...

Board Mentors at Frontier

The Wall Street Journal had a thought-provoking article yesterday about succession planning at Frontier Communications. At that firm, CEO Maggie Wilderotter has asked her Board members to serve as mentors to key executives who appear to be her potential successors. The rather novel process has some clear benefits for a firm as it plans succession, though it certainly takes a certain breed of CEO to be willing to adopt this approach.

Healthcare Summit

This week President Obama brings together Congressional leaders from both parties to discuss healthcare reform. Unfortunately, the cameras will roll at these meetings. The President should consider changing those plans. He should consider making them closed meetings. Why? Consider that our Constitutional Convention more than 200 years ago took place in private so that delegates could discuss big ideas frankly and candidly, and so that they could introduce innovative ideas for discussion. Similarly, in a more recent example, the 1983 Social Security reform took shape behind closed doors. Ultimately, of course, the ideas from both of these private, momentous meetings had to be approved in a public vote. However, people crafted these ideas in an atmosphere that promoted candid dialogue and open discussion of novel ideas.

Creativity and Youth

This article from the weekend edition of the Wall Street Journal describes the research of Professor Dean Simonton and others regarding the productivity of researchers in various fields. Simonton sought to examine whether breakthrough work seemed to be the product of the young, i.e. scientists and scholars in their 20s and 30s. Indeed, Simonton's work shows that, in fields such as physics, scholars perform groundbreaking work in their late 20s. In a number of fields, scholars seem to peak in their 20s and 30s. Simonton explains that scientists may peak at an early age in many fields because they are more willing to challenge conventional wisdom and consider novel explanations. Is the early peak age true in all fields? According to Simonton, it is not. Areas with well-defined theories and principles, such as chess, math, and physics, tend to see people peaking at a young age. Fields with more ambiguity skew toward a later age for peak productivity.

A lesson for all of us can be derived from these conclusions. We all need to seek out novelty as we grow older, to combat the natural tendency for us to get wedded to ideas, theories, and principles to which we are accustomed. Cognitive science now shows that novelty spurs the brain in many ways. Attempting to learn new things as we grow older forms a sort of exercise for the brain that may have many benefits.

Breaking Amazon's Monopsony

Do you know what monopsony is? Economists define monopsony as a market where you have only one buyer. It's the mirror image of monopoly - a market where there is only one seller.

Why do we care about the definition of monopsony? Well, the recent developments in the e-book market sparked some curiosity on the part of many folks. How is that book prices rose after Apple announced the introduction of the iPad? After all, doesn't competition reduce prices? My colleague, Keith Murray, has a terrific blog post on this subject.

Here's my take: Prior to Apple's entry into this market, Amazon had something closely resembling a monopsony in the e-book market. They dominated the market. They were the principal buyer of e-books. Thus, they had a great deal of market power relative to book publishers. The entry of Apple into this market, with the iPad, has essentially broken the monopsony. Now, there are multiple significant buyers of e-books. As a result, the book publishers have gained some leverage, and they can command a higher price for their products. Now, in the long run, prices may again fall as the market evolves. For now, though, we have an interesting scenario whereby prices have risen as a monopsony situation comes to an end.

Smart Planet Blog

Smart Planet's Pure Genius blog has posted an interview with me, titled "Decisions, decisions: Expert sheds light on how to make better choices."

Duane Reade Acquisition

Walgreens announced today that they are acquiring Duane Reade, a 257 store pharmacy chain in New York City. The deal provides Walgreens a powerful position in New York, where Duane Reade locations seem to be on every other corner, particularly in Manhattan.

The articles written about the acquisition all note that Duane Reade has the highest sales per square footage in the industry. Let's consider that for a moment. What does that mean? Typically, we think of sales per square foot as a critical metric of retail success. However, in the case of Duane Reade, we have to proceed with caution. The New York City locations involve very expensive real estate. Thus, one needs a great deal more sales per square foot simply to cover the additional overhead costs.

Yes, the Duane Reade locations generate a great deal of revenue per square foot since they are in such a high population, high traffic area. In addition, Duane Reade perhaps has some market power given their dominant position in the geographic area. However, the appropriate way to assess Duane Reade, and really any retailer, is to understand the return on investment for a square foot of retail space. That number would incorporate the revenue per square foot, but it would also account for the investment required to pay for that space, institute capital improvements, and the like. By the way, capital improvements will be a key factor for Walgreens, as many of the Duane Reade locations are not in very good physical shape. Walgreens will have to make further investments to upgrade the appearance of the stores.

Retailers Get Tough on Brands

CNN Money's website has a good article documenting how large retailers are streamlining the number of branded products on their shelves. As you might expect, Wal-Mart features prominently in this development. The article describes how retailers are reducing their product assortments, i.e. Do we really need 50 different types of toothpaste on the shelf?

Why might retailers streamline brand and product assortment?

1. Private label offers an attractive, value-oriented option for consumers, and it provides attractive margins for the retailers.

2. Reducing assortment offers an opportunity to drive higher volumes on a smaller set of SKUS, thereby increasing inventory turnover (thus driving return on assets higher).

3. Fewer SKUs means less confusing displays for the consumer, and more opportunities to showcase particular products in a more prominent way.

4. A reduction in SKU count and brand assortment may reduce logistics costs and administrative expenses, particularly if the retailer now has to deal with fewer suppliers and supplier locations.

5. Pitting brands against one another in a battle for shelf space enables retailers to extract concessions from key suppliers, thereby reducing costs of goods sold and increasing margins.

6. Retailers may have an opportunity to reduce the square footage of their store footprint, particularly as they experiment with urban and "neighborhood" store types.

Of course, large retailers are not necessarily breaking new ground here. Smaller retailers have been very successful with this limited SKU strategy for some time. Consider, for instance, the small but highly successful New England grocer, Stew Leonard's, as well as the popular national chain, Trader Joe's.

Earnings Manipulation

The Wall Street Journal reported over the weekend on a fascinating new study by Professor Joseph Grundfest of Stanford Law School and doctoral student Nadya Malenko of Stanford Business School. The authors studied 27 years worth of earnings reports (489,000 quarterly earnings reports). They examined earnings not just to the penny, as usually reported, but actually looked to the tenth of a cent. Of course, each digit should appear in the tenths place 10% of the time. However, these scholars found that an earnings report that ended with a "4" in the tenths place tended to occur less often that statistically expected (only 8.5% of the time, in fact). the numbers "2" and "3" also occurred less than expected by chance. The scholars coined the term "quadrophobia" to describe this phenomenon!

What about firms that later restated results or were found to have irregularities in their financial statements? It turns out that their earnings end with a "4" in the tenths place more than expected by chance. Hmmm... What's going on? It appears that companies may be edging up their earnings to the point where a "5" ends up in the tenths place, so that then they can round up to the next cent. That may not seem substantial, but consider for a moment how stock prices rise and fall significantly when a company misses earnings estimates by just a penny, or beats expectations by a cent.

What I find truly amazing is how much attention continues to focus on earnings, when all those finance professors around the world preach that cash flow, not earnings, should be the focus of investor analysis. Still, journalists report extensively on EPS results, and many companies appear to spend a great deal of time "massaging" those numbers.

Uniqlo's Expansion Strategy

Fast Retailing Company of Japan, which owns the very successful global retailer Uniqlo, indicates in today's Wall Street Journal that they will be on the hunt for acquisitions in Europe and the United States. The company has tried to gain a foothold with its Uniqlo brand in these western markets, but it has struggled at times. I visited the company's flagship store in New York City (in SoHo) with a group of my students. The store is terrific and apparently quite successful. However, the company closed several suburban locations that it attempted to open in the Northeast.

One thing that I found fascinating about Uniqlo was the T-shirt design competition that they conduct each year. People submit thousands of entries each year, and Uniqlo produces and sells the top submissions. In New York, the store features an amazing wall of t-shirts with innovative designs. This competition represents yet another wonderful example of how to truly engage your customers, while also reaching outside the firm to tap into innovative ideas.

As for the acquisition strategy, Fast Retailing will have to be cautious about following in the Gap's path. The Gap operates multiple chains (Banana Republic, Old Navy), and it has struggled to maintain true distinctiveness among these brands at times. The lines have become blurred, and that has hurt the core brand in particular. Of course, the Gap operates these chains in the same geographic market. Fast Retailing appears to be focusing on acquisitions in areas where Uniqlo is not strong, so perhaps they have less of this overlap concern.

CFO Magazine Interview

You might wish to take a look at this CFO magazine article for which I was interviewed at length. The title is: "Escaping the Executive Bubble."

Hermes, Coach to Open Men's Stores

The Wall Street Journal reports today that luxury good firms Hermes and Coach plan to open stores catering specifically to men. The strategy has a number of appealing features. Certainly, they appear to have evidence that many men do not enjoy having to shop for themselves in a store predominantly catering to females. Perhaps more importantly, data clearly show that more men are shopping for themselves when it comes to apparel, as opposed to our parents' generation, when wives often did a great deal of the apparel shopping for their husbands.

What challenge will the stores face? The last line in the article struck me as perhaps the most important one: "Still, there is one kind of customer brands are careful not to alienate in the men's stores: 'women who want to buy gifts for a guy,' Coach's Mr. Tucci says." Herein lies the critical issue facing these luxury retailers. How does one create a store atmosphere and shopping experience that caters to men without alienating the female shopper there to purchase for her husband, son, etc.? These luxury retailers will have to strike a delicate balance: make the atmosphere highly appealing to men, and clearly distinct from their other stores that cater mostly to females, while not alienating women.

Switch: Finding Bright Spots

Fast Company has published an excerpt from Chip and Dan Heath's upcoming book, Switch: How to Change Things When Change is Hard. As you may know, the Heath brothers wrote a best-selling book titled Made to Stick a few years ago.

In the excerpt, the authors explain how we can be easily overwhelmed when we face a complex problem that has a wide array of causes. How do we approach such a situation? They argue that we should search for bright spots. What do they mean? The authors tell the story of Jerry Sternin and his attempts to address malnutrition in Vietnam. Sternin went to a village and identified the children who were larger and healthier than the typical child. He examined how those families lived and how they ate. He discovered some important differences in eating habits and diet. Then, Sternin worked with the community to bring small groups of families together to prepare meals in a new manner consistent with how the better-nourished families cooked and ate. That village and many others achieved wonderful results. It's a remarkable story! Here is the Heaths' conclusion:

"In tough times, we'll see problems everywhere, and "analysis paralysis" will often kick in. That's why, to make progress on a change, we need to provide crystal-clear direction -- show people where to go, how to act, what destination to pursue. And that's why bright spots are so essential: They provide the road map... You may not be fighting malnutrition, but if you're trying to change things, there are going to be bright spots in your field of view. And if you learn to identify and understand them, you will solve one of the fundamental mysteries of change: What, exactly, needs to be done differently?"

I look forward to reading the book, due out next week!

SuperFreakonomics and Car Seats

I just read SuperFreakonomics by Steven Levitt and Stephen Dubner, and I enjoyed the book as much as the best-selling original Freakonomics book. While much has been made of the chapter on global warming, I actually found the material on children's car seats to be more fascinating, particularly as a father of three young children. Levitt's research suggests that car seats may not prevent fatalities more effectively than traditional lap and shoulder seat belts for children older than the age of 2. To examine the empirical work behind the book, take a look at this scholarly paper. Here's an excerpt from the conclusions to that research paper:

"The empirical evidence presented in this paper, however, suggests that for children aged two and up, child safety seats provide no discernible advantage over traditional lap and shoulder belts, and only a marginal improvement relative to lap-only seat belts in preventing fatalities. These conclusions are robust to the inclusion of a wide array of covariates, analyzing a variety of sub-samples of the data, including vehicle fixed-effects, and correcting for sample selection in the way the FARS data set is constructed. An obvious question to ask, although one which is beyond the scope of the FARS data, is the extent to which the failure of child safety seats to outperform seat belts is a consequence of child safety seats frequently being improperly installed. Indeed, NHTSA (1996)estimates that more than 80 percent of all child safety seats are incorrectly installed. Based on crash tests, Kahane (1986) argues that properly installed car seats reduce fatailities by 71 percent, compared to 44 percent for improperly installed safety seats. Thus, there may be potential gains to achieving better installation. On the other hand, it is worth noting that when I conducted my own crash tests at an independent lab using lap and shoulder belts on dummies corresponding to children aged 3 and 6, the seat belts performed well within the guidelines the federal government has established for child safety seats, and just about as well as the (properly installed) child safety seats that I tested. While far from definitive, the crash tests I conducted suggest that even with proper installation, there may not be clear advantages of car seats over seat belts."

I must say that I admire Levitt for taking on such controversial topics. I also liked his response to Transportation Secretary Roy LaHood's criticism of his research.

Peyton Manning and the Recency Effect

In the aftermath of an exciting Super Bowl, let's consider a lesson we all can learn from the hoopla surrounding Peyton Manning in the days leading up to the Super Bowl. During the entire two weeks leading up to the big game, we heard expert after expert pronounce Peyton Manning as the greatest QB to ever live, or perhaps right on par with the great Joe Montana. Everyone presumed that he would win the Super Bowl. Was all that hype really justified? (As a Patriots and Tom Brady fan, I was perplexed, to say the least!)

Overall, going into last night's game, Peyton Manning had 9 wins and 8 losses in his playoff career. Until his only Super Bowl win in 2006, he had a reputation for performing poorly in the postseason. That championship season changed perceptions. Yet, he lost both of his playoff games in the two seasons after that championship. This year, though, he led his team to the Super Bowl once again. People seemed to forget his postseason struggles, his inability to play his best on the big stage. Even in 2006, when his team won 4 games and lost none in the playoffs, he had only 3 touchdowns and 6 interceptions during the postseason... not exactly stellar. No one seemed to remember these facts.

Last week, no one also seemed to remember that Joe Montana won 4 Super Bowls and didn't lose any, while throwing 11 touchdowns with ZERO interceptions in those games. Overall, he won 16 games and lost only 7 in the playoffs. Yet, people proclaimed Manning the greatest ever last week.

What happened to all the experts, who surely don't forget Joe Montana's greatness or Manning's playoff struggles of the past? The lesson is that humans are incredibly vulnerable to what psychologists call the recency effect. We have a strong tendency to place too much emphasis on information and evidence that is readily available, such as recent events. We are incredibly myopic. The Manning hype provides a powerful example of the recency effect in action.

Toyota: A Cultural Defect

Many people have expressed surprise at Toyota's recent quality troubles. Naturally, one should be surprised to see such a highly regarded quality leader encounter trouble of this scale and scope. Many observers, including me, have noted that Toyota's quality issues have been building for awhile, as the company's rapid recent growth stressed the Toyota Production System. However, this Los Angeles Times article suggests that Toyota's problems run much deeper than many observers have suspected. The LA Times documents a history at Toyota of hiding or denying quality problems, or trying to delay product recalls. If we concur with the newspaper's assessment, then we must conclude that Toyota has a much deeper cultural problem, not just a short term issue related to the torrid growth of the past few years. Interestingly, the company is so well known for encouraging workers on the front lines to speak up when they see a defect or problem. This open culture has enabled them to surface problems on the line, and to fix them proactively so as to achieve high quality. Yet, it appears that this same frank and candid dialogue may not be occurring when it comes to top management communicating with its dealers and customers. Today, Toyota's chief executive finally spoke to the press about the firm's recent troubles. His late communication with the public may also be another indicator of the cultural challenges the firm faces. Toyota has a great deal of work to do. They must not only fix this set of defects and understand how to prevent them in the future; the firm must also address the issue of whether and why it has been slow to come clean on defects over time.

Chanos on China

Hedge fund manager and famous short seller Jim Chanos explains his views on the potential overheating of the Chinese economy in this video. Chanos, you may recall, became very well known for his investment call on Enron long before others saw the problems at the company.

Power Corrupts

Lord Acton once said, "Power corrupts. Absolute power corrupts absolutely." This week, The Economist reports on some new research by psychologists Joris Lammers and Adam Galinsky. In an experiment they conducted, they examined people in four different states: 1) high power, believed to be achieved legitimately, 2) low power, believed to be legitimate, 3) high power, believed to be achieved illegitimately, 4) low power believed to be illegitimate.

These scholars found that high power individuals who believed that, "they were entitled to their power readily engaged in acts of moral hypocrisy." On the other hand, low power individuals did not engage in moral hypocrisy. In fact, they tended to be harder on themselves than on others, when judging immoral behavior (such as stealing an abandoned bicycle). Lammers and Galinsky coined the term "hypercrisy" to describe that behavior. Now, here is the most interesting part: the high power individuals who believed that they had been ascribed that power, but were not really entitled to it, actually behaved just as the low power individuals did. What's the conclusion? It appears that the feeling of entitlement among powerful individuals actually becomes the fundamental driver of misbehavior and immoral behavior. Of course, we all knew this intuitively, but the stark findings here provide some persuasive empirical evidence, while also showing us the interesting "harsher on themselves than others" effect for low power individuals.

Does Easy = True?

The Boston Globe had a fascinating story in its Sunday edition about the burgeoning literature on what is known as "cognitive fluency." Cognitive fluency refers to how easy it is to think about something. Psychologist have demonstrated that making a statement easier to think about can increase the likelihood that people will believe the statement to be true. What do we mean by easier to think about? Psychologists have shown that printing a statement in an easier-to-read font, or making sentences rhyme, can increase the probability that individuals will conclude that the statement is true. Studies have also shown that stocks with easier to pronounce company names tend to outperform those with very difficult pronunciations.

On the other hand, psychologists have also shown that, in some circumstances, cognitive "disfluency" can have a profound impact. Put simply, making something more complex or difficult to comprehend can sometimes jar us into thinking more carefully about a subject. We might even catch mistakes. For instance, scholars have found that printing the question “How many animals of each kind did Moses take on the Ark?” in a more difficult-to-read font can raise the number of correct responses quite significantly (What's the answer? Noah took the animals on the ark, not Moses!).

I believe this current stream of research has some important implications for marketers, as they consider how to persuade and influence consumers to purchase their products. All marketers should explore these new studies about cognitive fluency.